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The Wrong Way & The Right Way To Change Your Mortgage
Does a lower mortgage rate always save you money?
In 2008 a 5 year fixed rate of under 6% seemed a very good deal. Not now that sub 4% has been common.
The simple answer must surely be to pay the 3 months interest penalty that everyone knows about, move to a cheaper rate and save money.
WRONG
The Interest Rate Differential (IRD) penalty can mean it is better to stay with he higher rate.
This totally legal clause is in the fine print and is only relevant when there are significant drops over a small period of time in the interest rate. Any borrower thinking of changing rates today needs to be aware of the IRD. Calculations can vary from lender to lender but are generally similar. The reason for choosing a lower rate must be to reduce the interest payments and that the balance will be reduced within the same time line as the existing term.
How to calculate the IRD:
- A) Date of mortgage June 6th 2009.
- B) Maturity date March 1st 2013.
- C) Term left 44 months.
- D) Current rate 5.84%.
- E) Possible new interest rate 3.74%.
- F) IRD (D minus E) 2.10%.
- G) Mortgage balance $188,000.
- H) Annual IRD ( G multiplied by F) $3,984.
- I) Total IRD owed ( H divided by 12, then multiplies by C) $14,476.
A 4 step process shows whether it is worth getting out of a current mortgage and “cash in” on today’s lower rates:
- Calculate the IRD; $14,476 as above.
- Monthly interest at current rate; example above at 5.84% $914.93.
- Monthly interest at new rate; example above at $3.74% $585.93.
- Calculate the possible saving over the term of the mortgage; $914.93-%585.93 = $329 per month. Over 44months equals $14,476.
In this example the IRD is exactly the same as the saving over the period of the mortgage and raises the question if it is worth changing?
